Gross Royalty Trust Agreements

The late 1940’s were the golden years for conventional oil exploration in Alberta. The seismic technology used to discover the giant oil and gas bearing Devonian-age reef at Leduc in 1947 was applied throughout southern Alberta. Additional major light oil discoveries followed rapidly at Redwater, Stettler, Golden Spike and Bon Accord. By 1950, most of the available freehold mineral rights within the area of southern Alberta which came to be known as the ‘Golden Triangle’ had been leased.

The oil discoveries of the late 1940’s not only changed the economic future of Alberta, but also made wealthy those freehold mineral owners whose mineral rights happened to lie within the area of the discoveries.

Sometime in the late 1940’s,freehold owners within southern Alberta (and Saskatchewan) began to be approached by ‘entrepreneurs’ with a novel idea which purported to improve their chances of sharing in the benefits of this new found oil prosperity – ‘gross royalty trusts or GRT’s’.

At the time, a 12 ½% royalty rate was standard in the lease agreements offered to freehold owners by the energy industry. The ‘pitch’ from the entrepreneurs involved the freeholder assigning a 12 ½% royalty interest to a trust company which would then issue unit certificates of ownership in the trust to the freehold owner. The freeholder could sell unit certificates to third parties, trade unit certificates with other freeholders who had established their own GRT’s, gift unit certificates to family members, or retain these certificates for his or her own account.

From the standpoint of freehold owners, most of whom were members of the farm community struggling to make ends meet following the great depression, the sale of unit certificates provided much needed immediate cash. Typically, the entrepreneur promoting the GRT scheme would purchase several units (typically 12 ½ units were issued by the trust company). In addition, some energy companies (notably Scurry Rainbow Oil Limited – now Devon Canada Corporation) made it a practice to acquire unit certificates from freehold owners.

In addition to the immediate cash advantages that GRT’s provided to freeholders who sold unit certificates, the trading of unit certificates with other freeholders provided the freeholder with the opportunity to participate in successful wells even if no well or a dry hole was drilled on his mineral rights.

The earliest GRT agreements were kitchen-table types of agreements. As time passed, the agreements were refined by the various trust companies that became involved. The most active trust company was Prudential Trust which had about 50% of the business. Other active trust companies included Guaranty Trust, Security Trust, Montreal Trust and Royal Trust. In all cases, the involved trust company would file a caveat against the freehold mineral owner’s title protecting its interest in the GRT.

The trading of GRT unit certificates became so widespread that securities regulators became concerned and in 1957 the Alberta Securities Commission imposed restrictions on the trading of GRT’s. These restrictions largely put an end to the creation of GRT’s.

For the next 30 years, energy companies that had established production from mineral rights leased from a freeholder whose mineral rights were burdened with a GRT accounted to the GRT trustee for the 12 ½% royalty assigned under the GRT and the trustee then accounted to the holders of unit certificates in the GRT. In 1987, a legal issue having to do with GRT’s that had long troubled oil and gas lawyers came before the Court of Queen’s Bench of Alberta. The issue was whether the royalty interest assigned to the trustee in a GRT was an interest in land or merely a contractual right. In Guaranty Trust Company of Canada v. Hetherington1, the trial judge ruled that the royalty assigned in the GRT’s before him was not an interest in land. This meant that the GRT applied only to the royalty in the lease which existed at the time the freehold mineral owner had entered into the GRT and any other leases entered into by that mineral owner. The GRT did not apply to leases entered into by successors or assigns of the mineral owner.

The GRT’s before the trial court in Hetherington were a form of GRT used by Prudential Trust primarily in the 1950 – 1952 period. This form of GRT came to be known as a PTC-1. According to evidence presented in subsequent litigation2, approximately 1,907 PTC-1 GRT’s were entered into during the pre-1957 period and 329 were producing in 1993.

The Hetherington trial court ruling was appealed and in 1989 the Alberta Court of Appeal added to the confusion by failing to address the interest in land issue3. The Appeal Court focussed on Clause 25 of the PTC-1 form of GRT which states:

“The Owner hereby covenants and agrees with the Trustee that, in the event that any lease that may be in existence as at the date of this Agreement is cancelled for any reason or in any event that no lease is in existence as at the date of this Trust Agreement, he shall and will in negotiating any lease or other instrument for developing the said lands reserve unto the Trustee the full 12 1/2% Gross Royalty hereby assigned to the Trustee.”

The Appeal Court ruled that in situations where the lease referred to in a PTC-1 form of GRT expired by effluxion of time and was not ‘cancelled’, the GRT did not apply to subsequent leases.

The Hetherington rulings resulted in a number of additional legal actions as freehold mineral rights owners contested the validity of both their PTC-1 GRT’s and other more sophisticated forms of GRT. In response, the various trust companies applied for and were granted interpleader orders which allowed them to pay the contested ongoing royalties associated with all of their GRT agreements into court. This resulted in hardship for many freehold mineral owners who had come to depend on their GRT unitholder distributions. A number of the trust companies responded by providing the freehold owners with the ‘opportunity’ to sign ‘patch agreements’ which confirmed the validity of their GRT’s and allowed for the continued distribution of unitholder royalties. In FHOA’s view, the letters from the trust companies describing this opportunity did not fully or properly disclose the issues involved and resulted in many freeholders agreeing to something which was not in their best interest.

To address the growing number of legal actions involving GRT’s the Court of Queen’s Bench appointed a judge to manage all of the litigation and resolve the payout of more than $14 million in disputed royalties which had been paid into court. In 1990, the Court of Queen’s Bench ordered a trial of test cases to resolve the interest in land issue. In Scurry Rainbow Oil Ltd. v. Galloway Estate4, the trial judge considered the issue of whether a GRT gave rise to an interest in land or a contractual interest in the context of a Prudential Trust PTC-1 GRT, a Guaranty Trust GRT and a Security Trust GRT. In all three instances the trial judge ruled that an interest in land had been created. On appeal, the trial judge’s ruling was upheld by the Alberta Court of Appeal5. All other GRT’s which have been litigated have been found to create interests in land.

In result, most GRT’s, other than PTC-1 GRT’s, remain binding on the current mineral owners.

Some freehold owners appear unaware that their mineral titles are burdened by a GRT. This may give rise to serious issues in some situations. For instance, during the 2003 – 2009 period when coal bed methane (CBM) development in south central Alberta was a focus of industry activity, a number of CBM developers insisted that freeholders sign leases with sliding scale royalties of from 6% to 18% depending on monthly production volumes. Most GRT’s contain a clause requiring the mineral owner to reserve a 12 ½% royalty to the trustee in any new lease negotiated. A freeholder who signed a 6% - 18% sliding scale royalty lease and whose mineral rights were burdened with a 12 ½% GRT could find himself in the position of paying to have his coal bed methane produced in low productivity situations (the 6% lease royalty would be due to the trustee and the freeholder would have to make up the additional 6 ½% royalty due to the trustee from his own pocket).

An additional problem that can arise with respect to GRT’s is found in the royalty clause of CAPL leases. The 12 ½% royalty assigned to the GRT is a “prior disposition” and in each of CAPL 88, CAPL 91 and CAPL 99, the freeholder agrees to make any payments associated with such prior dispositions out of the royalty he receives (see sub-clause 4(c) in CAPL 88 and CAPL 91 and sub-clause 4(f) in CAPL 99). The last thing a typical freeholder needs is the obligation to account to a GRT trustee on a monthly basis. The referenced sub-clauses also contain a provision allowing the energy company-lessee to elect to account to the trustee on behalf of the freehold owner-lessor. Most energy company-lessees do elect to account to the trustee but the practice is not uniform.

Many holders of GRT unit certificates consider the costs charged by the GRT trustee to administer the GRT to be excessive. Freeholders should be aware that in situations where the freehold mineral owner holds unit certificates in the GRT which burdens his mineral rights a partial collapse of the GRT may be possible. The effect of such a partial collapse is to transfer those units held by the mineral owner from the GRT to the mineral owner thereby freeing the mineral owner from GRT administrative costs. Interested freeholders should contact the trustee of the GRT burdening their mineral rights.